What does it mean to be a fiduciary? With the looming DOL Conflict of Interest Rule (commonly referred to as the fiduciary rule) scheduled to come into effect next April, this question is no doubt on the minds of most financial professionals.
Indeed, many who would have answered that question confidently even 12 months ago are trying to understand what all the fuss is about and what it means for them and their practice. While there is still much uncertainty around the impact of the rule, one thing is certain—it will create change across the financial services industry.
There are varying perceptions, positive and negative, around the rule depending on the constituency. I believe the insurance industry and insurance-based distribution will respond to the rule as mandated and continue to deliver valuable products to our customers.
But before we explore how the rule is changing the industry, let’s take a look at more elemental issues. What does it mean to be a fiduciary, and how will this change affect you?
First, consider these questions:
1. Do you believe you offer prudent recommendations in the best interest of your clients?
2. Do you avoid misleading statements in your sales process?
3. Do you feel you’re reasonably compensated for the services you offer your clients?
If you quickly and confidently answered yes to these questions, congratulations are in order. You are, at least intentionally, meeting the impartial conduct standards required of a fiduciary under the new DOL rule. So why, then, is the rule such a big deal?
How did we get here?
In the 40-plus years since the federal government enacted the Employee Retirement Income Security Act (ERISA), the retirement landscape has changed dramatically. That’s one reason the DOL has asserted it introduced changes to its fiduciary rule. Between 1974, when ERISA was passed, and today, the ways in which people think about and save for retirement have evolved. Back then, individual retirement accounts (IRAs) were brand new. Today, IRAs capture roughly 30 percent of the retirement market—and trillions of dollars in assets that, and until the DOL’s ruling, hadn’t been subject to ERISA’s protections. That was a sticking point for DOL leaders.
The major intent behind the rule as asserted unabashedly by the DOL was to increase the DOL’s oversight of and influence on the IRA marketplace. Under the new rule, the DOL will hold the ERISA plan and IRA marketplaces to a broader fiduciary standard, which will be enforced by the DOL, in the case of ERISA retirement plans, and the plaintiff’s bar (under the newly-required “Best Interest Contract (BIC)”) in the case of rollovers and IRAs. The rule also will govern distributions from qualified accounts—even after they’ve rolled over into an IRA.
Fixed indexed annuities also have been drawn into the rule. Under the final rule, a BIC will be required to receive a commission when recommending a fixed indexed annuity. This was one of the “surprises” in the final rule, and could end up having some of the greatest impact on the market.
It’s worth noting that the rule does not cover non-qualified assets, so a financial professional can offer recommendations on these products without being subject to the requirements of the rule.
In essence, the rule expands who is considered a fiduciary and what constitutes a fiduciary act. Under the old rule, these five points defined “fiduciary advice” as:
1. Making investment recommendations
2. On a regular basis
3. Pursuant to a mutual understanding
4. As the primary basis for a plan’s investment decision
5. Individualized to a plan’s needs
The new definition of fiduciary eliminates numbers 2, 3 and 4. So, in effect, anyone who is compensated for making investment recommendations, which are individualized to a plan or individual investor’s financial situation, is acting as a fiduciary.
Key implications and some silver linings
Some of the key implications of the fiduciary rule relate to disclosure, fixed indexed annuity changes, and the extended rules to rollovers and distributions. Each of these areas represents a center of significant change—as well as some areas of opportunity in the industry for those who are able to pivot.
Increased disclosure will most likely create downward pressure on fees and commissions, and we’ll see standardized compensation models emerge. Looking at the real estate industry may provide an indication of how this will play out for financial professionals. When looking to sell a home, people can select the level of service they want–everything from a full-service broker to a listing agent only, to self-representation. Disclosure and transparency provide consumers an opportunity to assess value for cost and choose their desired level of service. No one is surprised by the compensation, and most consumers, including me, will continue to choose full-service brokers, because they’re willing to pay for the value of more robust services.
I fully expect low-cost and “do it yourself” models will continue to emerge in financial services, just as they have in real estate. But for high quality financial professionals, the fiduciary rule and the corresponding increased disclosure and transparency create a requirement to call attention to the full value provided to clients. Indeed, many professionals are already in good shape in this regard, and many more will learn to pivot and communicate with their clients about all that financial professionals do. While the costs associated with these services will be disclosed, the value of the services will also be revealed.
As the fiduciary rule relates to the BIC and fixed-indexed annuities, the most dominant implication will likely be a disruption of existing distribution channels.
The BIC is an enforceable contract between the financial institution and client that commits the financial institution, through the actions of the financial professional, to a fiduciary standard of giving advice in the client’s best interest. Under the final rule, a financial institution is defined as a bank, insurance company, broker-dealer or RIA. Notably, independent marketing organizations, who are the primary distributors of fixed indexed annuities, are not included in the definition (although they can apply for an exemption). Absent such an exemption, the insurance carrier will be required to sign the BIC and assume the associated liability (the BIC will be essentially enforced by the plaintiff’s bar). The rub here is that the insurance company typically doesn’t have sufficient control or influence over IMOs in today’s world to be comfortable accepting this fiduciary liability risk. As a result, IMOs and carriers alike, continue to review strategic alternatives to continue to provide valuable advice and products to consumers in their best interest, in compliance with the new DOL rule.
The outcome is still not clear, and it is likely to vary between different companies and firms, at least in the short term. What is clear is that the BIC requirements will prove to be a catalyst to reevaluate business models and strategies. Increased regulations and compliance in the new environment may make it more difficult to go it alone. Companies, marketing organizations, and financial professionals alike will need to evaluate their business models, consider their core competencies, and identify what is needed in the emerging environment.
While independent distribution will clearly continue to play a significant role, we may see companies and IMOs being more selective in who they align with to ensure that they can establish the policies, procedures, and sufficient controls required in the new environment.
It will also lead to changing roles for many financial professionals. Some may resign from certain aspects of their business, but others likely will choose to accept the new standard and align themselves with firms that can help them thrive. In most cases, financial professionals will need to more closely align with a financial institution (or marketing organization with established fiduciary capabilities). Importantly, financial professionals should also keep in mind that marketing groups, firms, and carriers likely will become more discerning with respect to the professionals they bring on board.
Rollovers and Distributions
As the fiduciary rule pertains to rollovers and distributions, it is sure to apply pressure to the asset-gathering business. Smaller rollover opportunities may become less appealing, and more “stay in plan” decisions may be made.
If this sector represents a small portion of your revenue, it will be important to weigh the potential cost associated with continuing in the same direction versus the potential benefits of reshaping your practice and looking for new opportunities. Financial professionals who have a sizeable block of assets under management may, however, simply have to deal with the complexity of the new rule.
If financial professionals find themselves squinting to see the opportunity in all of this, they’re not alone. But some options are beginning to come into the picture. One could simply choose to focus on traditional insurance and risk transfer products for non-qualified assets that are outside the scope of the DOL and avoid the complexity altogether. Alternately–and more likely– renewing concentration on these products may help offset potential lost revenue.
Another option would be to identify additional products or solutions for your client base to help restore or even grow revenue. Asset-based long term care products have the potential to be a nice fit in the new environment as a wealth protection tool. If a financial professional is already talking to a client about fee structures, it makes sense to talk about products like these and repositioning assets.
As much as financial professionals may be feeling fatigued by the combination of market volatility and regulatory change, savvy clients may be experiencing the same. Being able to introduce a solution that is stable, predictable and guaranteed may be an ideal complement to an existing business model.
What next?
The industry is evolving, as it has been since its inception. We happen to be at a point of more significant change than many of today’s professionals have experienced in their careers, and that can be unsettling. But those who remain intent on finding opportunity amidst the uncertainty will create the strongest advantages for their businesses after the fiduciary rule is implemented.
Walking into the offices of a nearly 140-year-old company every day has some advantages–among them being a constant reminder that change in the industry is both inevitable and survivable. Nearly 140 years ago, my company’s earliest clients were still 50 years away from having electricity in their homes. Times certainly have changed, and the financial services industry continues to evolve right alongside new technological advances. But the strength, stability, and peace of mind that foundational insurance products represented to so many families then remains at the core of our business today. It’s important to look at the fiduciary rule through that lens as we create plans to thrive in the new environment.
OneAmerica® is the marketing name for the companies of OneAmerica.
